The mortgage meltdown of 2008 triggered the Great Recession, which prompted banks to tighten credit and raise underwriting standards. This in turn gave impetus to alternative, or non-bank, lending, a sector that includes commercial lending companies, payday lenders, peer-to-peer marketplace lenders, and hard-money real estate lenders. Each type of lender has its own characteristics, but four differences between bank and non-bank lending form a common thread:
- Credit ratings: Banks predominantly rely on credit ratings and credit histories to evaluate loan applications. Consumers with less-than-good ratings or scant credit histories have virtually no chance of receiving a bank loan. Non-bank lenders are in general much more willing to provide loans applicants with low credit ratings by adjusting interest rates, demanding collateral, and/or using alternative underwriting methods. Hard-money lenders typically lend up to 70 percent of the value of the underlying real estate, with the borrower supplying the remainder. By concentrating on the property rather than the borrower, developers can receive hard-money financing quickly even when they have less than stellar credit scores.
- Speed: Banks are notoriously slow to approve loans. They require voluminous paperwork and extensive credit checking as the process slowly grinds through the bank’s loan committee. Non-bank lenders usually offer a streamlined application process and rapid approval/funding, often depositing loan proceeds in as little as one business day. For hard-money lenders, the underwriting process evaluates the property under construction/rehabilitation, and for all intents and purposes skips the borrower credit check. This tremendously speeds up the loan process. Experienced hard-money lenders know their local real estate markets well and can often arrive at a property value in less than a day.
- Size of loan: Many banks have a minimum size loan threshold that bars small loans. A bank’s bureaucratic overhead costs preclude it from extending loans that are not “profitable,” which is how it sets the minimum loan size. Non-bank lenders are typically lean operations with much lower operating costs, allowing them to offer small loans, as low as $100 in the case of payday loans. Commercial loans as low as $5,000 are widely available. You can expect a hard-money lender to provide up to $1M in financing, and sometimes more.
- Interest rates: Banks can afford to offer the lowest interest rates because they lend only to applicants with gilded credit ratings. Non-bank lenders charge higher interest rates in return for greater loan access. Some commercial and hard-money lenders offer fairly low interest rates, whereas payday lenders charge astronomic rates. A good hard-money lender will offer bank-competitive rates to borrowers who are near-miss, non-bankable candidates.
When looking for a good hard-money lender, pick one that has a variety of loan programs, such as fix-and-flip/rehab loans, acquisition loans, condo conversions, bridge loans, private flexible loans and long-term loans. By choosing a well-rounded hard-money lender, you’re sure of getting the right program at the right price.